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String Of Downgrades Creates Buying Opportunity For Oil Stocks

Oil

Analysts from New York-based investment bank Seaport Global Securities LLC, Barclays Plc., Morgan Stanley, Macquarie Capital Ltd. and Capital One Securities have recently downgraded a slew of big oil companies, explorers, oilfield service providers and other E&P companies.

The downgrades come as the sentiment in the oil sector turns bearish, with the market now believing that without further steps from OPEC and its allies, oil is likely to fall to as low as $20s per barrel in the next year.

But, will oil really retest the lows and stay there?

In 2016, oil prices bottomed around the $26 per barrel mark and ever since, traders were hopeful that OPEC would cut production and tackle the looming supply glut. Though OPEC was unable to clinch the deal in the first half of 2016, the markets believed that an agreement could still be reached.

Hope that OPEC would strike a deal and hope of declining crude oil production in the United States kept oil prices supported for most of the second half of 2016. Once the deal was finalized in end-November of last year, analysts turned bullish on oil. A Reuters poll forecast WTI crude oil prices to average $55.23 per barrel levels, while a Wall Street Journal survey of major banks expected WTI crude to average $54 per barrel in 2017.

Bank of America Merrill Lynch was even more bullish, expecting oil to skyrocket to $69 per barrel by June 2017.

(Click to enlarge) Related: Iraq Dethrones Saudi Arabia As India’s No.1 Oil Supplier

But in my earlier articles, I have mentioned that oil will find it difficult to trade above $60 per barrel levels, because the U.S. shale industry was indicating that it would quickly ramp up production if oil prices came close to $50 per barrel levels.

At the current juncture, though, the Middle East is in a fluid state following the boycott of Qatar by Saudi Arabia and its allies, and it is looking less likely that crude oil prices will hit $20s per barrel levels in the near future.

By various estimates, U.S. shale oil drillers need crude oil prices of close to $40 per barrel to be profitable. This may vary depending on the well and the location, but below $40 per barrel levels, all the producers will again be back in damage control mode.

A host of smaller companies and others who are more prudent will want to scale back their production plans. Therefore, the growth of U.S. oil production in the second half of this year will be much slower than the first half. Hence, the 10 million barrels per day of forecast might not happen by December of this year if crude oil prices hang around these levels or fall into the $30s.

Second, OPEC will not want to lose this battle, which would prove that it is incapable of shoring up prices – if not higher, at least keeping it close to $50 per barrel – hence, we should see OPEC either curtail production for Nigeria and Libya, or deepen the cuts for the remaining members. Even if it is only for a few months, I believe that OPEC will go through this. Related: Solar And Wind Revolution Happening Much Faster Than Expected

However, OPEC will be mindful to only cut enough to keep oil prices close to $50 per barrel, fearing the aggressive return of the U.S. shale oil producers as prices go much higher. Hence, a runaway rally in crude is unlikely. Oil is likely to remain range bound, occasionally shooting above and below the range.

Therefore, as and when oil prices fall below $40 per barrel, it would be a good time to buy into strong oil stocks for the long-term. This is not a short-term trade; hence, investors should be ready to weather some downturn—at least for a short period of time. The position can be liquidated once crude rallies to $55-$60 levels.

If, however, the new crown prince of Saudi Arabia, Mohammed Bin Salman, decides to abandon OPEC’s production cut deal and continue pumping oil for 2-3 years at rock-bottom prices to hurt the U.S. shale oil drillers, our analysis will be turned upside down. However, at the current juncture, the probability of this happening is very low. Hence, I remain bullish on oil stocks for the long-term, on any dips to the $30s per barrel levels.

By Rakesh Upadhyay for Oilprice.com

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  • jack ma on June 27 2017 said:
    SA must sell oil in the gold backed petro-Yuan or SA will become a failed state.

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